Will Oil Derail the Recovery?

Here we go again. As we know by now, most of the major downturns that have occurred in the US and the world, since the 1970s, have been preceded by sudden increases in oil prices. We are at levels, currently around the $100/barrel mark, that will impact inflation, GDP growth and potentially employment.

As described by the U.S. Energy Information Administration, since the United States is a net importer of oil, higher oil prices affect the purchasing power of U.S. national income through their affect on the international terms of trade. The increased price of imported oil forces U.S. businesses to devote more of their production to exports, as opposed to satisfying domestic demand for goods and services, even if there is no change in the quantity of foreign oil consumed.

When oil prices increase, the consumer suffers – sounds all too familiar. Purchasing power diminishes as consumers use more of their income to pay for products that are directly affected by oil such as gasoline, heating petroleum, and jet fuel. Less money is spent on other goods and services causing a vicious cycle of contraction, due to decreases in retail expenditures and diminishing confidence. Since companies depend on oil for transportation and other operational needs, the increased costs to run businesses are passed along to the consumer in the form of inflationary prices. To further compensate for increased energy costs and less demand, firms will reduce the bottom line of expenses by laying off workers. This scenario results in lower GDP and higher unemployment.

Since we have made some real progress during the last 12 months for economic recovery, I am hoping we do not fall back into a recession pattern, but oil is a real risk here. After Tunisia, the unrest spread to Egypt, causing a spike in prices due to worries about the possibility of the Suez Canal shutting down; one of the most important oil transport passageways in the world. The Libya uprising caused more market jitters as 1.5 million barrels a day of oil was choked off, later covered by Saudi Arabia, the world’s largest oil exporter, to prevent shortages. The unrest appears to be continuing and spreading as protests have been reported by CNN in Iran, Iraq, Syria, Algeria, Morocco, Jordan, Oman, Yemen and others in the region. Interestingly, it was reported yesterday that there could be protests in Saudi Arabia coming. Since it doesn’t take much for oil prices to react quickly - that would certainly adversely affect the market if it really happened. Also, the high peak spring/summer driving months are approaching - could we have $5 a gallon gas prices? Some analysts think it is possible, given the uncertainly of what is happening in the world and how oil reacts to it. I certainly hope not, because the scenario I outlined above could become a reality.

Read about the higher Oil Prices' Impact on Housing Recovery
C. Cohn
Cohn-Reilly Report